Dieharder - Thanks for the explanation. That makes sense. It sounds like you re-balance based off of being over/short a certain percentage in your allocations, correct? Rather than just re-balancing every quarter-end, for example. I"m still trying to determine which path to go with. I personally like the idea of only rebalancing every quarter or semi-annually to reduce the tax implications and since I'm lazy.

That is correct. Major asset allocation such as stock / bond ratio will follow a 5% band. It works as follows:

stock / bond ratio 60/40 - you rebalance when stocks are at 65% or 55%

As I have found out over time, it takes extreme market moves to drop the asset allocation to this level. Last time I had to do this was in 2008 and last week is only the second instance in three years.

I have found that this technique avoids re-balancing too frequently, and thus allows momentum to play out. It still does not capture the market bottom, if I were to modify this to a 10% band then I think I would have bought at the market low in 2009 and not late 2008 which was still early.

But that kind of market moves are rare, at least prior to 2008 and so far experienced this month. I think 5% band is reasonable to let you re-balance after capturing momentum effect, you may not catch the bottom, but the idea of re-balancing is never to do that.

The other thing I mentioned is instead of buying equity / bond in a fixed ratio with new contributions, I have decided to let all new contributions go into cash after 2009. Therefore I am not re-balancing when equities go up, only buying them when they go down because I am accumulating cash on the side while equities are going up. It's same as selling them and buying fixed income. Once equities fall, I use the accumulated cash to buy them.

It is easier to track the transactions and you can determine the purchase instead of your paycheck schedule deciding it for you.

Lbill wrote:According to news reports, ordinary investors are leaving the stock market in droves in their 401(k)s and IRAs. They've found out why there is an equity risk premium - it's because there is actual RISK involved. As Ed Easterling wrote: "risk is not a knob" that you turn to produce higher returns. Sometimes the knob isn't connected to anything, or maybe it's connected to a trap door.

Hi Lbill,

The below "Investors Flee . . ." story in USA Today at once participates in the hype and undercuts it a few paragraphs in:

While the [$23 billion] outflow dollar amount is "eye-catching," says Brian Reid, the ICI's chief economist, it is tiny compared with the estimated $6 trillion of total assets invested in stock funds. The latest week's outflows "account for one-half of 1% of all equity assets," he says.

I agree that investor demand for stocks could dry up over time, but it's got a long way to go and the alternatives to stocks are already looking pricey . . .

Best,Pete

I think investor interest in stocks will depend partly where this current slow down ends up and how quickly markets recover. History has shown that fifty percent declines (2000-2002, 2008) have not reduced investor interest in stocks substantially. However, stocks have rebounded very quickly with the help of a very supportive Federal Reserve. Not sure what would happen if we drop 80% and equities don't rebound as fast. Only time will tell

Lbill wrote:According to news reports, ordinary investors are leaving the stock market in droves in their 401(k)s and IRAs. They've found out why there is an equity risk premium - it's because there is actual RISK involved. As Ed Easterling wrote: "risk is not a knob" that you turn to produce higher returns. Sometimes the knob isn't connected to anything, or maybe it's connected to a trap door.

Hi Lbill,

The below "Investors Flee . . ." story in USA Today at once participates in the hype and undercuts it a few paragraphs in:

While the [$23 billion] outflow dollar amount is "eye-catching," says Brian Reid, the ICI's chief economist, it is tiny compared with the estimated $6 trillion of total assets invested in stock funds. The latest week's outflows "account for one-half of 1% of all equity assets," he says.

I agree that investor demand for stocks could dry up over time, but it's got a long way to go and the alternatives to stocks are already looking pricey . . .

Best,Pete

I think investor interest in stocks will depend partly where this current slow down ends up and how quickly markets recover. History has shown that fifty percent declines (2000-2002, 2008) have not reduced investor interest in stocks substantially. However, stocks have rebounded very quickly with the help of a very supportive Federal Reserve. Not sure what would happen if we drop 80% and equities don't rebound as fast. Only time will tell

In the short term investor sentiment will drive where stock market will go, in the long run real stuff such as earnings will determine stock prices. As of now, expectation is low, it could go lower, and end up staying lower if growth remains sluggish. An 80% drop in stock prices means a depression era scenario with people lining up for daily wage jobs and returning disappointed. We are far from that situation.

Stock market recovered in 2003 and 2009 because earnings recovered, not just Fed Policy, policy of course did help. This time too corporate profits will drive stock prices eventually. Who knows where it is going to be in 3, 5, 10 years from now?

I am however optimistic that a gloabally diversified portfolio will find some components having growth regions in it over a 10 year period. That should be sufficient to provide a modest positive rate of return for the portfolio. Everything else is just noise in the short term.

You call that a freefall? It didn't even get down below the freefall a week agoon Aug 9 and 10 when it was down around 1120.

Why, when I was young, we had real free falls. Not these silly -4% down days. I remember there was one time back in '87, I think that was during the Hoover administration, when the market fell -20% on one day. And back in -08 there were plenty of days it was down 6, 7, 8 and 9 percent. This generation, with their fancy iPods, smart iPhones and high-frequency trading, have no appreciation for what a real freefall is.

nisiprius wrote:I'm not predicting anything, I'm as much of an Eeyore as the next man, and I never subscribed to the cult of equities. But I do want to ask this. Think back as best you can to when the thread started.

Is what happened next what anybody expected? If so, did you happen to write it down and date it?

That's not freefall. Like a silent movie stunt, where the comic falls off the building ledge and lands on a springy flagpole, maybe, but not freefall.

With my tongue firmly in cheek, I am going to say that I called it--when I said:

On Monday, stocks might shoot right back up. Or they might plunge some more. Or they might diddle around for weeks leaving us all on tenterhooks and then plunge some more. Or not.

Nailed it!

It's not an accident that the largest intraday gains since August 8th have coincided with the Fed's scheduled POMO (Permanent Open Market Operations).

Google "frontrunning the fed" and you'll learn all about the biggest open secret on what moved the market upwards during the past few weeks. At the moment, the Fed hasn't announced any more POMO days.

In other words, without the Fed, stocks would probably not have the support they have right now.

Last edited by Gumby on Fri Sep 09, 2011 1:31 pm, edited 1 time in total.

nisiprius wrote:I'm not predicting anything, I'm as much of an Eeyore as the next man, and I never subscribed to the cult of equities. But I do want to ask this. Think back as best you can to when the thread started.

Is what happened next what anybody expected? If so, did you happen to write it down and date it?

That's not freefall. Like a silent movie stunt, where the comic falls off the building ledge and lights for a while on a springy flagpole, maybe, but not freefall.

With my tongue firmly in cheek, I am going to say that I called it--when I said:

On Monday, stocks might shoot right back up. Or they might plunge some more. Or they might diddle around for weeks leaving us all on tenterhooks and then plunge some more. Or not.

On the interplay between the FED and STOCKS: Since Sept 1 – when QE was becoming a mainstream focus – if you only owned S&P on days when the Fed conducted Open Market Operations (in US Treasuries), your cumulative return is over 11%. in addition, 6 of the 7 times when S&P rallied 1% or more, OMO was conducted that day. this compares to a YTD return of 5.8%. the point: you would have outperformed the market 2x by being long on just the 16 days when – this is the important part – you knew in advance that OMO was to be conducted. The market's performance on the 19 non-OMO days: +70bps.

Another words, the pre-announced POMO days saw large intraday upswings in stock prices. (I stress "intraday" because there were POMO days that saw huge comebacks with small overall losses or gains from the previous day).

Essentially, the Fed purchased huge quantities of Treasury Bonds on those days, from the Primary Dealers, and the Primary Dealers were given instructions to invest that Fed cash in the market — just like what happened during Quantitative Easing. Traders in the know joined in on the momentum by "frontrunning the Fed". The operation artificially pumped up stocks (and/or minimized losses).

Last edited by Gumby on Fri Sep 09, 2011 3:10 pm, edited 8 times in total.

The Fed will update its POMO schedule on September 13, so by then we'll know when the next artificial stock pumping operation will resume.

I looked from May 2011 to today and there appears to be no measurable effect at a glance between scheduled POMO dates and market returns. Strictly buying to try to frontrun by buying the day prior to a scheduled POMO results in pretty flat or even some losses.

Bobalude wrote:I looked from May 2011 to today and there appears to be no measurable effect at a glance between scheduled POMO dates and market returns. Strictly buying to try to frontrun by buying the day prior to a scheduled POMO results in pretty flat or even some losses.

You gotta be kidding, buying the day before?!? By then, the price has long since been driven up.

I would want to buy 1 microsecond after they post the schedule. Or even better, get a peek at the schedule beforehand and buy the securities before the schedule is even posted. Then sell right after the schedule is posted. Front run the front runners.

Bobalude wrote:I looked from May 2011 to today and there appears to be no measurable effect at a glance between scheduled POMO dates and market returns. Strictly buying to try to frontrun by buying the day prior to a scheduled POMO results in pretty flat or even some losses.

You gotta be kidding, buying the day before?!? By then, the price has long since been driven up.

I would want to buy 1 microsecond after they post the schedule. Or even better, get a peek at the schedule beforehand and buy the securities before the schedule is even posted. Then sell right after the schedule is posted. Front run the front runners.

Both of you are wrong. It doesn't necessarily work if you buy the prior day or even before that. It's really just an intraday effect as the money enters the market. When the European market is open, overnight, stocks and S&P 500 futures have often crashed — due to Europe's debt issues — so that the US market opens lower than it originally closed the night before. If you buy the night before, hoping to realize a POMO gain, you can risk a lot happening before POMO begins. Whereas, if you bought in right at the open, on the POMO day, and sold before the close that day you would realize the full POMO effect (while avoiding the European markets).

For instance, right after the Labor Day holiday (September 6) was one of the last POMO days. We saw a slight decline in the S&P 500 overall, but that's because stocks made a huge comeback after opening with a crash from the day/night before (due to Europe woes).

If you bought in the night before, it wouldn't have worked for you. But, if you bought in at the open, you would have done very well that day. As I keep trying to tell you, it tends to be an intraday effect.

I reallocated last week to lighten up on equities. I contemplated dumping all of them, just on a hunch. I know, hunches are bad, very bad. Nonetheless, today I am kicking myself in the crotchal area for not having heaved them all overboard.

dLdV wrote:I reallocated last week to lighten up on equities. I contemplated dumping all of them, just on a hunch. I know, hunches are bad, very bad. Nonetheless, today I am kicking myself in the crotchal area for not having heaved them all overboard.

Sounds to me like you don't belong in equities at all if a few days of decline cause this reaction.

dLdV wrote:I reallocated last week to lighten up on equities. I contemplated dumping all of them, just on a hunch. I know, hunches are bad, very bad. Nonetheless, today I am kicking myself in the crotchal area for not having heaved them all overboard.

Sounds to me like you don't belong in equities at all if a few days of decline cause this reaction.

You may be correct. In any case, I'm stuck with them for now. Selling would violate the supreme rule of "Thou shallt not buy high and sell low."

livesoft wrote:The TotalStockMarket as represented by VTI would have to drop at least 4.5% in a single day for it to be a ReallyBadDay. Some other asset classes would have to drop even more.

European indexes are down 5%+ today (FTSE, CAC), but they won't look like it for the US ETFs due to the time lags - they're catching up to the big drop from yesterday afternoon when Europe was closed. So you might be a buyer of stocks today if you were based in the EU, but not based in the US (assuming the thresholds were similar for the EU stocks, they probably are somewhat higher).

Every time the market takes a drop someone adds to this thread. But if you look at the history of the dates in this thread stocks were seldom in "freefall" when people said they were.

Since the late 1990's the S&P 500 has moved essentially sideways, but there's been a lot of volatility. It's like being in a boat on a rough ocean - sometimes a wave will pick you up and the boat will soar upwards, then the wave drops you and you plummet back down, but the ocean never drains out; sea level is still sea level even if it doesn't feel very level.

I think all this volatility is great - I have a conventional stock-and-bond-and-rebalance portfolio and I have a trading portfolio. My stock-and-bond-and-rebalance portfolio has ploddingly gained over the years through many rebalances despite the sideways S&P. And the trading portfolio has done fantastically well. If the markets had been placid over the last 12 years, but with the same closing prices today, neither portfolio would have done as well as they have. Volatility is a gift to us all.